Falling prices may negate U.S. Steel cost-cutting plan

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U.S. Steel's Carnegie Way efficiency initiative has inspired hope that new president and CEO Mario Longhi will be able to reverse the Pittsburgh steel producer's string of five consecutive losing years. But some analysts are concerned that falling steel prices could wipe out whatever savings the campaign will generate.

U.S. Steel "appears stronger with new management removing costs, but this may not be enough in a falling price environment," Citi Research analyst Brian Yu wrote in a memo to clients this month.

Gordon Johnson of Axiom Capital Management agrees. He told clients Feb. 5 that domestic steel prices "are likely in the beginning innings of a major correction lower." In a phone interview, Mr. Johnson said U.S. hot roll prices, which stood at $680 per ton a month ago, are now $640 and are probably headed below $600.

Every $30 drop in the price of hot rolled coil -- a widely used commodity sheet product -- translates into $465 million in lost profits for U.S. Steel, Mr. Johnson said.

"I don't think their cost savings are going to be in excess of $465 million," he said.

Much to analysts' chagrin, Mr. Longhi steadfastly has refused to identify how much in savings his disciplined look at operations and strategy will generate.

During a January conference call discussing U.S. Steel's $2.1 billion loss last year, Mr. Longhi said the company expects to generate $150 million in new cost savings this year. He said the company also will benefit from lower coal, pension and retirement benefit expenses.

Mr. Yu wrote that U.S. Steel's coal, pension and retirement benefit costs dropped by nearly $100 a ton last year, but that the savings were eliminated by a $29-per-ton drop in hot roll prices. He expects hot roll prices to average $630 a ton during the second half of this year.

Analysts say there are plenty of reasons to forecast lower prices, including a nearly 600 million ton global surplus of steel making capacity. Most of the excess capacity is in China, which accounts for about half of the global industry.

"I'm predicting a bad 2014 and, for the ones that survive, a good 2015," said IHS economist John Anton. "As long as the world has too much steel, price increases won't stick."

He said U.S. producers have been very disciplined in controlling output and "have done everything they could to mitigate the damage."

The problem, he said, is the Chinese.

"The only thing that will get me to come off this dire outlook is a voluntary cut in Chinese production," Mr. Anton said.

Overseas, steel prices are $75 or more a ton lower than U.S. prices. That has prompted foreign producers to send their metal here. Applications for import permits jumped 19 percent in January and are expected to jump again in February, Mr. Johnson said.

Then there's the fact that steel prices move in tandem with prices for iron ore and other raw materials, which also are falling. Morningstar analyst Andrew Lane said that's why he believes steel prices will fall through the end of 2015.

Last week, the U.S. Department of Commerce issued an adverse ruling in a trade complaint brought by U.S. steel makers last year over imports of tubular goods used in the energy industry. The agency declined to impose penalties on shipments from South Korea, the largest producer, and placed lower-than-anticipated duties on imports from eight other countries.

U.S. Steel's tubular business accounted for nearly half of the company's operating income last year. The trade case ruling will pressure the company's profit margins, JPMorgan analysts told clients last week.

Analyst John Tumazos said domestic producers also will be dented by the stronger U.S. dollar, which makes imports more competitively priced compared to domestically produced steel.

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